Cook-Hauptman Associates, Inc.

Economic Losses Attributable to Variety

By Jim Cook ( 1993 )


( Retail and Distribution Losses Production Losses Development Losses ¯ )

Retail and Distribution Losses

  1. Out-of-Stock: These are the losses resulting from having demand for a particular variety of a product, but not physically having it on hand.  This loss is severely aggravated by variety, and attempts to alleviate its effects by increasing products on hand exposes those additional products to all the losses enumerated below.

  2. Seasonal: These are the losses resulting from having stock on hand at the time when consumer demand drops (e.g., Christmas, end of summer, ...). This kind of loss has a predictable time of initiation. Event based products (e.g., Christmas, Halloween, Mothers' Day, ...) tend to be associated with sharp drops in demand, whereas, seasonal demand tends to have gradual demand drops. Retailers who compete on variety and the distributors who serve them will experience losses due to having many small lots left over.

  3. Fad: These losses result from consumer changes in taste, and are intended to be distinct from cyclical losses. In general, the timing (and the extent) of these losses is hard to predict. To discount these particular losses, it is common practice to charge higher retail prices for "Fad" products (i.e., those varieties which might experience these kind of losses, albeit to an unpredictable extent).

  4. Advances: These losses occur (especially in a rapidly advancing industries such as the computer industry) when a new model or a lower price is announced and offered. The effect is to force the kind of demand drop-off that occurs under fad decay except that the tolerance for higher retail prices is often low.

  5. Quantization: These losses result from not having the benefit of aggregation of large quantities by which retailers, and to a much lesser extent distributors, can smooth demand and thereby avoid being stuck with a large number of small lots. These losses are the consequence of increased variety of products and the proliferation of retail outlets.

  6. Coordination: These are the losses represented in larger fixed costs (administration, equipment, space, training, and quality of personnel) necessary to manage, promote, and service the increased complexity that accompanies creased variety.

  7. Miscellaneous (Spoilage, Warranty, Governmental, Theft, ...): These kinds of losses, generally, are not a direct consequence of variety. However, to the extent increased variety results in larger inventories, there is a corresponding increase in the vulnerability of that inventory to these kinds of losses.


Production Losses

  1. Transition: Variety always entails more production transitions, and therefore, in so far as mass (as contrasted to information) is involved, entails unproductive time and, often, waste of material. The unproductive time is the time from having quality production of one variety to the onset of quality production on the subsequent variety. The waste of material is the sum of all material consumed during transition such as outputs while the process is stabilizing.What??

  2. Scope: Producers often deal with the production of a wide variety of products by employing general purpose machines. These general purpose machines (unless they enjoy a large market themselves, as in the case of computers) usually cost more than comparable (in terms of thruput and quality) special purpose machines.

  3. Yield (Training, Rework, and Spoilage ...) These are the losses attributable to trying to reduce (e.g., training), recover (e.g., rework), or eliminate (e.g., inventory) losses from off grade product. The off grade product may be the result of personnel error, equipment deficiencies, and/or transition waste.

  4. Coordination: These are the losses represented in larger fixed costs (administration, space, training, and quality of personnel) necessary to manage, produce, and service the increased complexity that accompanies increased variety.

  5. Miscellaneous (Learning, Theft, Governmental, ...): Learning has both good and bad consequences of variety. The learning due to constantly switching the production mix is beneficial in being able to reduce the costs of change, but the widely accepted notion of cost reduction due to raw volume (the so called learning curve effect) is determined by the reduction of average quantity of production of each individual variety. Losses due to theft and governmental intervention are not especially increased by variety beyond the extent increased inventory is exposed.


Development Losses

  1. Amortization: These are the losses in profit that occur because lower unit sales force higher unit charges to recover the expense of development. Sometimes this is offset by the overall increase of the aggregate sales, particularly when the development cost of a variation (e.g., another color) is small and the incremental sales are larger (as a % of overall sales than the incremental cost is as a % of the overall cost of development).

  2. Amelioration (Delaying, "Satisficing," Recycling, ...): These are losses that derive from the additional expenses of design resulting from attempts to ameliorate the recurring losses caused by variety. Examples of such design strategies are the delaying of assembly (even, for example, painting or dying a specific color), delaying of delivery (by designing small lot packaging or high response, low cost distribution), "satisficing" (coined by Herbert Simon and meaning to enhance an offering so as to compensate for a small lapse of specificity) to reduce variety without losing sales, and recycling to provide some economic and societal relief for all the product waste attendant with high variety.

  3. Delay: These are the losses due to lost sales caused by the delay in time to market resulting from the increased development complexity of variety.

  4. Coordination: These are the losses represented in larger fixed costs (administration, project management and quality of personnel) necessary to manage, design, and integrate the increased complexity that accompanies increased variety.



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Copyright © 1993 by James E. Cook